Entry and Regulation – Evidence from Health Care Professions Prof. Frank Verboven Presentation at DG-Competition 13 December 2006 “The Economic case for professional services reform”

Background to this study oAcademic research paper oJoint work with Catherine Schaumans, doctoral student at K.U.Leuven oFinanced by K.U.Leuven and Fonds Wetenschappelijk Onderzoek (Flemish Science Foundation)

Health care markets Complicated markets (like many markets …) Demand side: patients need Medical diagnosis Medical treatment, including drugs Supply side Pharmaceutical companies investing in R&D Physicians treating patients Government: broad access to medical care Offer high reimbursement Guarantee sufficient geographical coverage

Implications of high reimbursement policy Agency problem Physician has an incentive to prescribe too many drugs Common solution Separate physician and pharmacy ownerships Competition problem Pharmaceutical companies and pharmacies may have an incentive to charge too high prices Common solution Regulate prices, including pharmacy gross margins

Broad geographic coverage policy Combine: relatively high regulated gross margins geographic entry restrictions to guarantee: sufficient entry in the unattractive areas without triggering excessive entry elsewhere Such policies have been followed in many European countries, including Belgium, France, Italy, etc.

The Establishment Act in Belgium In every municipality, the number of pharmacies is restricted based on population criteria. The population criteria are modified depending on -the number of pharmacists within a pharmacy -the distance between two pharmacies

The scope of our study Estimate an econometric model of entry and competition with geographic entry restrictions Evaluate the policy of relatively high regulated gross margins combined with tight entry restrictions. Is it indeed in the public interest (ensure sufficient geographical coverage) or is it rather in the pharmacies private interest?

General intuition of the entry model We observe the number of pharmacies (and physicians) per town We relate these to demographics, including population size. Interpretation of results -If population size needs to increase disproportionally to sustain an additional pharmacy, then entry implies enhanced competitive behavior. -If predicted number of sustainable firms would be higher than what is legally allowed, then there is room for additional entry.

VariableDescriptionMeanStd. D. # pharmaciesNumber of pharmacies # physiciansNumber of physicians ln(population)Logarithm of number of inhabitants % youngFraction of population, 17 years or younger % oldFraction of population, 65 years or older % foreignFraction of population with foreign nationality % unemployed Fraction of population between 17 and 65, that is unemployed FlandersDummy variable, 1 for region of Flanders mean incomeMean Income (/10,000) Source: NIS, Ecodata Demographics (NIS, Ecodata) Number of firms (RIZIV) Data on 847 small Belgian towns

Number of pharmacies Total Total, restricted entry Total, restricted entry (%) Total

Uncensored bivariate ordered probit Censored bivariate ordered probit General model with strategic complements Pharmacies’ payoff equation Constant (1.18) (3.40) (1.82) ln(population) 2.49 (0.06) 1.95 (0.12) 1.43 (0.13) % young (2.48) 0.73 (9.18) 0.22 (4.26) % old (2.43) (5.20) (3.54) % foreign (0.94) (0.96) (1.08) % unemployed 9.20 (2.22) (4.85) (4.40) Flanders (0.14) 0.13 (0.34) 0.11 (0.25) Income (0.14) (0.18) (0.19) 2.26 (0.11) 1.50 (0.18) 1.09 (0.23) 3.64 (0.13) 2.56 (0.20) 1.94 (0.30) 4.83 (0.15) 3.14 (0.22) 2.37 (0.35) (0.29)

Physicians’ payoff equation Constant (0.94) (1.12) (0.98) ln(population) 2.54 (0.07) 2.53 (0.08) 2.27 (0.07) % young 3.45 (2.08) 2.22 (2.25) 2.02 (2.15) % old 6.85 (1.84) 6.81 (1.90) 5.98 (1.89) % foreign (0.73) (0.69) (0.72) % unemployed 2.30 (1.83) 2.29 (1.98) 0.67 (1.89) Flanders (0.12) (0.13) (0.13) Income 0.32 (0.11) 0.32 (0.12) 0.37 (0.11) 1.30 (0.10) 1.32 (0.10) 1.23 (0.10) 2.34 (0.12) 2.36 (0.12) 2.27 (0.13) 2.99 (0.13) 3.09 (0.13) 2.91 (0.14) (0.19) (0.29) (0.83) (0.83) corr 0.32 (0.03) 0.05 (0.07) (0.09) Log Likelihood-2, , ,740.6

Summary of empirical findings Profitability is positively affected by -town size (population) -% old and % unemployed. Additional entry by pharmacies reduces profits, but this: -is only due to reduced sales; -is not due to enhanced competitive behavior. The entry restrictions are strongly binding, i.e. -at regulated profit margins more pharmacies want to enter.

What is the combined impact of -reducing the profit margins -loosening the entry restrictions on -total number of pharmacies -number of towns without pharmacy? This enables us to evaluate the public interest view of the current regulation, i.e. the guaranteeing of broad geographic coverage. Policy simulations

Net markup change No change-50% No change in entry restrictions Number of pharmacies Number of towns without pharmacies Full free entry in pharmacy market Number of pharmacies Number of towns without pharmacies

Additional policy experiments Introducing free entry and lowering regulated profit margins, such that the total number of pharmacies across all towns remains constant, leads to: -large markup reductions (tax savings) net margin drop by about 62% gross margin drop in the range of 10-18% -no significant loss in geographical coverage (-0.8%).  No public interest motivation for the current regime.

What next in Belgium and elsewhere? Gradual erosion of profits due to a ceiling on the regulated profit margins  Ultimately entry restrictions may become redundant. Can profit margins themselves be deregulated?  May require rethinking of reimbursement policies. What market failures motivate the many other restrictions in the establishment Acts?

What next in Europe? Similar or other restrictions apply in many other countries Urgent need for more independent economic research